October 26, 2011

The purpose of Section 2036(a) is to include in a decedent’s gross estate the values of any inter vivos (during life) transfers that are essentially testamentary (at death) in nature. Section 2036(a) applies only when three conditions are satisfied:

The decedent made an inter vivos transfer of property;

The decedent’s transfer was not a bona fide sale for full and adequate consideration; and

The decedent retained an interest or right in the property that they did not relinquish before death.

The recently published Tax Court case of Estate of Clyde W. Turner, Sr. provides an in-depth discussion of Section 2036 with regards to determining whether the assets transferred during life were includable in the decedent’s estate.

The decedent, Clyde W. Turner, Sr., had formed a successful lumber company with his brothers during his life. Clyde used income generated by the company to acquire additional wealth, primarily consisting of bank stock. His family retained an estate planner who subsequently established the Turner & Company Limited Liability Partnership (the partnership.)

The partnership was funded with cash, shares of bank stock, CDs, and various other investment accounts. Its three general purposes listed in the partnership agreement were to make a profit, to increase the family’s wealth, and to provide a means whereby family members can become more knowledgeable about the management and preservation of their assets.

In addition to the three general purposes, the partnership agreement also listed nine specific purposes including: management by the most qualified person, elimination of fractional ownership, facilitation of gifting, protection of assets, protection against creditors, protection against failed marriages, increased family involvement regarding investments, avoiding family disputes, and governing family transfers.

At this point Clyde was in his 80s and in good health. He opted to retain $2 million of assets outside of the partnership. Later, he and his wife gave limited partnership interests in the partnership to their three children and grandchildren. The following year Clyde became seriously ill and passed away. At the time of his death, he still held a .5% general partner interest and a 27.8% limited partner interest in the partnership. The IRS issued a notice of deficiency, determining that the value of assets Clyde transferred should be included in his gross estate under Section 2036.

The court engaged in a lengthy analysis of Section 2036 and first determined that an inter vivos transfer took place when Clyde’s assets were transferred to the partnership in exchange for his general and limited partner interest. The court next looked to whether the exchange constituted a bona fide transaction, thus excepting the transfer from Section 2036.

A bona fide sale exception requires both an arm’s length transaction, and full and adequate consideration. Because the exchange here was within the context of a family limited partnership, the record must show the existence of a legitimate and significant non-tax reason for the creation of the partnership.

The court found that the reasons provided in the partnership agreement failed to establish a legitimate and significant nontax reason for the formation of it. Although consolidation of assets could be a legitimate nontax purpose, this is not the case if the partnership is “just a vehicle for changing the form of the investment in the assets, a mere asset container.”

In this case, the assets consisted of passive investments that did not require active management. Clyde even stated that he wanted to form the partnership because he lacked a coherent investment plan. The court interpreted this as showing there was nothing unique to protect or perpetuate. Additionally, although resolution of family disputes may be a legitimate nontax purpose, no such purpose was found here. Any ill will existing among the children was not related to money, and therefore, could not be solved by creation of the partnership. Furthermore, family asset protection reason was also found unpersuasive. Additionally, the court noted several additional factors that indicated that the transfers were not a bona fide sale, including the following:

The decedent stood on both sides of the transaction,

The partnership was established without the other family members, co-mingling of personal and partnership funds and paying estate planning fees from the partnership, and

Assets were not transferred to the partnership until 8 months after its formation.

Ultimately, the bona fide sale exception did not apply to the decedent’s transfer.

The final inquiry concerned whether Clyde retained, for his life, the possession or enjoyment of the transferred property. Generally, property is included in a decedent’s gross estate, if he retained, by express or implied agreement, possession or enjoyment of the right to income from the transferred property.

Factors indicating that Clyde retained an interest in the transferred assets include a transfer of most of his assets, continued use of the transferred property, co-mingling of personal and partnership assets, disproportionate distributions to the transferor, use of partnership funds for personal expenses, and testamentary characteristics of the arrangement.

The first issue concerned the management fees Clyde paid to himself. The partnership agreement allowed for reasonable management fees, but the court found $2,000 per month to be excessive, especially considering evidence suggesting that he did not manage the partnership at all, and he had already retained enough assets outside of the partnership to satisfy his living expenses. The court also found that the partnership resembled an investment account, from which withdrawals could be made at any time, rather than a business activity conducted for profit.

The second issue concerned Clyde’s personal attachments to the bank stock – he had made it clear that he was fond of the stock and it was never to be sold. The court interpreted this as an implied agreement. Finally, the court found the family’s testimony – that tax savings were never discussed – to be lacking in credibility, which in turn affects the credibility of testimony concerning the intended purpose of the partnership.

The court went further and found that Clyde, under Section 2036(a)(2,) retained the right to designate the person who shall enjoy or possess the property. The court reached this conclusion by noting that Clyde, as a general partner, had absolute discretion to make distributions of the partnership income and had authority to amend the partnership agreement at any time without consent of the limited partners.

Consequently, Section 2036 includes the values of the transferred property in Clyde’s estate.

October 20, 2011

The general rule relative to Medicaid eligibility it that all transfers/gifts from a person are considered to be available to them for 5 years from the date of transfer, thus denying the person from obtaining institutionalized benefits.

This includes any portion of a trust that could be payable to them. However, with all rules, there are exceptions, and Congress has exempted certain trusts from Medicaid’s available resource provisions and from the transfer penalty provisions that apply to Medicaid long-term care services, so long as the trusts meet certain requirements.

For example, a special needs trust allows money to be set aside to provide for the special needs of individuals who require, or may someday require, Medicaid benefits, without affecting the beneficiary’s eligibility for these benefits. Likewise, a pooled trust is a type of special needs trust that is managed inexpensively by pooling large numbers of accounts, while providing disabled people with financial resources to be used for a variety of their needs.

In 2005, Pennsylvania enacted limitations (Section 1414) on the use of pooled trusts, which imposed restrictions based on:

The disabled individual’s age;

The characteristics of the expenditures trusts can make to the disabled person; and

What percentage of any funds remaining in the trust after the individual’s death can be retained by the trust to assist other individuals.

The Act also included a death penalty provision that allowed for termination of the entire trust for all beneficiaries if the trustee violated the act as to any beneficiary.

In response to this legislation, two Pennsylvania pooled trusts, and related plaintiffs, filed suit seeking to enjoin the Department of Public Welfare from enforcing the provisions of section 1414 that restrict Medicaid eligibility and require a minimum of 50% state reimbursement from the pooled trust. A federal court, in the recently decided case of Lewis v. Alexander, ultimately held that much of Section 1414 is unenforceable because it is more restrictive than what is permitted under federal Medicaid law.

Specifically, the Lewis court held the following provisions unenforceable because they are in conflict with, and more restrictive than, controlling federal law:

The provision that requires the beneficiary to have special needs that cannot be met without the trust;

The age requirement, And the court concluded that disabled people age 65 and older may form a pooled special needs trust;

The expenditure restrictions that required all distributions to have a reasonable relationship to the needs of the beneficiary;

The 50% pay-back provision, which states that a pooled trust may only keep 50% of the remainder left in the account after the death of a beneficiary without an obligation to reimburse the state for Medicaid expenses. The court held that pooled trusts may elect to keep the entire amount remaining in the beneficiary’s account at death; and

The court negated the death penalty provision.

Although the court enjoined the Department of Public Welfare from applying or enforcing the aforementioned restrictions, the remaining provisions of Section 1414 are still valid.

The decision in Lewis is a significant victory for clients, as it clarifies that disabled people age 65 and older are permitted to form pooled special needs trusts. This provides elder law attorneys and their clients with an additional planning tool for a disabled person, even when it appears that a long term institutionalization may be at hand.

Of course, there are some adverse consequences, such as the fact that the funds are not repaid to the family after the death of the beneficiary. However, the funds are available during that person’s life without the need to spend them for daily care, which is usually a preferred option, as opposed to spending the funds on long term care expenses, which would otherwise cause the entire sum to be expended without any possibility of use of the funds for non-necessary expenses.

This case is an important victory for people with disabilities and their families since it does provide an alternative in the long term planning process. The area of special needs trust planning often requires updating and conforming to laws and regulations that may change. Therefore, anyone considering establishing a pooled trust or similar option should be sure to engage a qualified professional before merely signing up to fund a pooled trust.

October 12, 2011

Over the past several years, some estate litigation cases have included the marriage of a person who was close to death, whether an elder or a younger person with limited life expectancy. These cases are different than those such as Groucho Marx and Anna Nicole Smith, where one party was relatively young and one was relatively old, but the older person was not necessarily in an end of life situation.

Sometimes these situations are basically marriages of convenience, and although “legally performed,” may be construed to be a sham. For instance, in recent history in New York, there were two cases that reached the courts in which the marriages were contested. In both cases, the marriages were declared to be invalid based on the incapacity of one of the parties.

Unfortunately, if you are a beneficiary or an heir in these situations, your primary recourse is to object to the will or file an action to set aside the marriage as being void based on incapacity.

Sometimes a caregiver marries their “boss,” thus having superior rights to inherit than children, especially when a will and other testamentary changes are made, such as beneficiaries on life insurance policies and retirement plans. In several such cases, the children did not even know that their parent had married until after the funeral, and it is very difficult to obtain testimony about a person post-death.

It is certainly easier to attend to an elder loved one’s affairs through a power of attorney and possibly a trust than have to litigate these situations, which costs time and significant expense and is also emotionally draining. In any case, it is important to know what your loved one owns for assets and attend to their affairs yourself to help assure that the plan proceeds without the interference of surprise, unwanted beneficiaries later in life or after death.

October 05, 2011

As many of you already know, the U.S. Treasury Department decided that government benefits need to be paid electronically. This means that benefits have to be electronically deposited into your bank account or can be “loaded” onto a debit card.

If you have already initiated receipt of federal benefit payments, including Social Security and Veterans’ Administration payments, they are already electronically or direct deposited to an account, and there is nothing further to do unless you wish to have them transferred to a different account. If no other action is taken, the payments will continue to be deposited on the previously scheduled date.

However, if you currently receive any federal benefit by a paper check, you have only until March 1, 2013 to switch to the electronic payment option. You might prefer to open a new checking or savings account and have those payments directly deposited to it.